Conflict Of Interest

by hilzoy

There is just no way that this ought to have been allowed:

"The Federal Reserve Bank of New York shaped Washington's response to the financial crisis late last year, which buoyed Goldman Sachs Group Inc. and other Wall Street firms. Goldman received speedy approval to become a bank holding company in September and a $10 billion capital injection soon after.

During that time, the New York Fed's chairman, Stephen Friedman, sat on Goldman's board and had a large holding in Goldman stock, which because of Goldman's new status as a bank holding company was a violation of Federal Reserve policy.

The New York Fed asked for a waiver, which, after about 2½ months, the Fed granted. While it was weighing the request, Mr. Friedman bought 37,300 more Goldman shares in December. They've since risen $1.7 million in value. (...)

Mr. Friedman, who once ran Goldman, says none of these events involved any conflicts. He says his job as chairman of the New York Fed isn't a policy-making one, that he didn't consider his purchases of more Goldman shares to conflict with Fed policy, and bought shares because they were very cheap."

Whatever Mr. Friedman might think, having a director of the New York Fed serving on the board of Goldman Sachs, and owning 98,600 shares of Goldman Sachs, became an obvious conflict of interest once Goldman became a bank holding company. The New York Fed regulates banks and bank holding companies headquartered in New York, New Jersey, and Fairfield County, Connecticut, and enforces laws governing them, in addition to doing various other things that can affect their share prices. Goldman Sachs is a bank holding company headquartered in New York. I'm not sure how a conflict of interest could be more obvious than that.

In saying this, I do not mean to impugn Mr. Friedman's motives. I don't know Mr. Friedman. For all I know, he is a pillar of rectitude and a prince among men. That doesn't matter. For one thing, owning stock in a company you regulate can influence you without your awareness. In fact, it's hard to see how owning so much stock that a mere $1 change in the stock price means that your net worth goes up by nearly $100,000 could fail to affect your thinking, however hard you tried. 

Moreover, even if you do manage to completely wall your decisions off from any such influence, conscious or unconscious, no one other than God can be certain of that. And if there's reason for people to wonder whether your decisions are influenced by your stock holdings, those decisions will be suspect. 

The legitimacy of the Fed's decisions is very important. The Fed and its subordinate banks are unaccountable bodies with enormous powers. It matters both that their decisions be, and that they be believed to be, made without undue influence by politicians, bankers, or anyone else. It will not survive otherwise. The fact that it has not seemed to be independent either of politicians or of Wall Street recently is a very big problem. It needs to be dealt with directly. But the least we can expect is that its directors not make things worse by having large and obvious conflicts of interest.

Comments

[urban legend]

There is no need to argue why this obvious conflict of interest is a bad thing, and by doing so you undermine your critical point. His intentions and moral compass are completely irrelevant. This is A + B = C.

[J. Michael Neal]

Just to play Devil's Advocate here for a moment, what was the alternative? If you think back to the events of last fall, turning down Goldman's request would have been extremely problematic, given all of the other conversions that were being approved. Further, there's no real evidence that becoming a bank holding company has done Goldman much good. It mostly turned into a conduit for giving them money that they didn't need, and that they since have declared that they didn't want.

There are a number of problems here, but I think that they are substantially more complicated than a simple conflict of interest. Pretending that an investment bank like Goldman was ever not deeply concerned with Fed policy, holding company or not, is silly. However, the very nature of the Fed guarantees that the big banks are going to have seats on the Fed's board.

Dealing with this would require an overhaul of the financial regulatory system far more thorough than anything that's been contemplated up to this point. Given my pessimism about getting anything meaningful through Congress on less complicated than this, I'm inclined to pretend I don't notice this, because making an issue of it can only make it more difficult to get anything useful done.

[hilzoy]

JMN: From the WSJ article:

"The regional Fed banks have three classes of directors: Class A, elected by member banks and representing them; Class B, elected by banks but representing the public; and Class C, representing the public but picked by the Fed. Under law, directors in Class C, including Mr. Friedman, and Class B can't be officers or directors of banks, and Class C directors like Mr. Friedman also can't own shares of banks. This means not of bank holding companies, either, by the Fed's interpretation of the 1913 law."

The banks will always have seats at the table, and it is set up that way. But he was meant to be occupying one of the other seats.

Also: there is an obvious alternative here, namely: ask him to divest himself of the Goldman stocks.

[russell]

there is an obvious alternative here, namely: ask him to divest himself of the Goldman stocks.

Bingo. Thank you.

[ScentOfViolets]

Follow the money. That's all that matters in politics today. Yes, that's a simplistic view. But it works very, very, very well in explaining 90% of what goes on.

That it - come to think of it - why I stopped being a libertarian some time ago - von's 'classic conservative'.

[J. Michael Neal]

The banks will always have seats at the table, and it is set up that way. But he was meant to be occupying one of the other seats.

I'm maintaining that this is a false distinction. Mr. Friedman was a Class C director already, despite sitting on the board of Goldman and owning Goldman stock. The only thing that changed was that Goldman became a bank holding company. To me, the idea that there is any additional conflict of interest because of this than there was when Goldman was just a huge investment bank, hedge fund, and several other sorts of major financial arms, is just silly.

If there is a problem with a conflict of interest here, then it exists because the Class C directors have ties with any financial company. The drawing line that exists is meaningless.